Wednesday, March 21, 2007

Short Attentionspan Theatre.......

It seems investors have been waiting for the Federal Reserve Board to change their wording in regards to interest rates for so long now. The hope was that they would take away their bias towards raising rates. Well be careful what you wish for. All the people who fool themselves into the idea that lower rates are good for the market are probably pinning their hopes on it can save the housing sector and reverse the recent trend in the real estate market. Human nature runs in cycles, and can not be derailed like a runaway train. It can be made to seem like somethings its not, but the inevitable cycle will run in course. How many successful attempts have their been by foreign central banks to manipulate their currencies? None come to mind, and many failures of large scale are evident.

So today the Fed dropped its tightening bias, and everyone had a party buying stocks. It is important to look at why they removed their bias, and what do they see on the horizon that maybe are not evident now. Their fear of inflation is not balanced by some other concerns. What happens when rates stop going up? Well for one the dollar becomes weaker and this can cause many things which the party goers today who bought stocks might not be focused on.

This is a weekly chart of the US Dollar Index. Its value in the beginning of 2002 was around 120. By the beginning of 2005 it was in the 80 range. That is a significant drop of over 30%. We do not feel this effect here domestically day to day as much as foreign investors and holders of our debt feel it. If you were a foreign owner of our stock market in 2002, and held it to 2005, you lost 30% just in the currency conversion regardless of what stocks you owned. It could not have been a profitable time.

This next chart shows the interest rate on the 10yr treasury versus the S&P 500. As rates were going down in, because of the underlying weakness in the economy, stocks followed. Once rates seemed to stabilize, then the focus went back to seeking value in equities. This was fueled by the fact they with rates so low, it was possible to borrow money in other parts of the world and invest it here in the states, for a seemingly risk free trade.

So now that the Fed has said rates are on hold, it can be good news if we are in a sweet spot. If they do however start cutting rates this fall, it will be because of some weakness in the economy. Most likely this will be the unemployment rate and its effects on the psychology of consumers. Will this mean inflation won't be a factor? No it won't mean that at all. We are large consumers without a doubt, but we are not the only reason for inflation. Twenty years ago we could get wrapped up in ourselves, and think we were the world. Today our consumption could decrease and inflation could still continue to grow because China and India are growing large scale economies.

When the US Dollar continues its down trend, the stronger currencies should be those from economies based with strong commodity resources. Two that come to mind are Canada and Australia, both are large mining countries and Canada has a significant energy industry. With today's rally we can see the strength in some of the metals and mining stocks. As the US Dollar weakens, it will make commodities traded in dollars more expensive to compensate for the dollar losing value. Below are some stocks that are in the metal and mining industry, that had some triangle formations. Look for volume to accompany any breakouts. Be selective and go with the best looking patterns.

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